Professor John Geanakoplos: So anyway, the course I'm going to teach is called Financial Theory. I'm going to teach an actual class. I'm going to spend the first half of the class talking about the course and why you might be interested in it, and then I'm going to start with the course. There are not that many lectures available in the semester so I'm not going to waste this one. So the first half of the class is going to be about why to study it and the mechanics of the course, and the second half of the lecture is going to be actually the first part of the course. It'll give you maybe an idea of whether you'll find the course interesting too.

So I think I'll turn this — I won't have too much PowerPoint here. So you should know that finance was not taught until ten years ago at Yale. It was regarded by the deans and the classically minded faculty of the arts and sciences as a vocational subject not worthy of being taught to Yale undergraduates.

It was growing more and more famous, however, in the world and there was a band of business school professors, Fischer Black, Robert Merton, William Sharpe, Steve Ross, Myron Scholes, Merton Miller, who had a huge following in business schools teaching the subject, and whose students went off to Wall Street, and more or less dominated the investment banking parts of Wall Street, and became extremely successful. Finance became the most highly paid profession. It became the most highly paid faculty in the university, although they were all in business schools. There are more physics PhDs working in finance now than there are working in physics.

So this merry band of financial theory professors didn't really believe in regulation. They believed markets left unfettered worked best of all. They believed in what they called efficient markets and the idea that asset prices reflect all the available possible information. So an implication of that is that if you want to find out whether a company's doing well or not you don't have to take the trouble to read all their financial reports, just look at their stock price. If you wanted to know whether a country's doing well or not you don't have to study its entire political system and current events, just look at the general stock market of the country and that'll tell you.

They believed that you could make as good returns in the market as a lay person as you could as an expert because all the experts were competing to try and get the best possible price, and so the price itself reflected all their knowledge and wisdom and opinions and so the lay person could take advantage of that by buying stocks. Everybody should be an investor, they felt. A monkey throwing darts at a dart board would do as well as any of the greatest experts.

Now, their own theory was basically contradicted by their own experience because all of them seemed to go out into the world and invest, and almost all of them made extraordinary returns and made a huge amount of money all of which made them even less popular in the faculty of arts and sciences.

So, a critical part of their theory was that the markets were so efficient, driven by people like them who are competing to exploit every advantage, and therefore compete away every advantage, and by doing that put all the information they have into the prices.